The CHAIRMAN. I suggest, without objection, that that article be placed in the record at this time. I had intended to insert it later, but now, since the question has been raised, it may go in here.

Doctor SPRAGUE. Without the headings ?

The CHAIRMAN. Without the headings.

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conservative capitalization of well assured earning power. A stock, shall we say radio, may pay huge dividends some years hence. That does not make it a good purchase on borrowed money at the current price.

The present security market exhibits all of the familiar earmarks of inflation and the symptoms of a speculative craze. It presents a situation altogether analogous with that in commodity markets throughout the world during the 12 months preceding the debacle in the spring of 1920, and not unlike the Florida land boom of more recent memory. In each instance is to be observed the same growing eagerness to buy among widening circles, stimulated rather than checked by advancing prices, and wholly oblivious to advances, in lending rates, always provided that increasing supplies of credit are somehow made available.

A security market that is functioning within reasonably safe limits is sensitive to changes in lending rates. When it is found to be absorbing constantly increasing amounts of bank credit at rising rates, the stock market is unquestionably under the controlling influence of a demand that rests upon no solid foundation of intelligent foresight. Were the consequences entirely confined to those who are tempted into speculative excess the course of the market would not be a matter of general concern. This seems to be the case with ordinary or moderate fluctuations in the security markets. The psychological influence unfavorable to business activity of moderate declines in security prices is negligible. If business at the time is in good shape it goes ahead regardless. On the other hand, an extreme decline of catastrophic proportions may well be believed to exert an independent unfavorable influence upon the course of trade, even though it does not involve serious loss to the lending banks, and must certainly have that effect if it does go to that length.

STABILITY POLICY OF RESERVE SYSTEM PARTLY RESPONSIBLE FOR INFLATION

A security market that is impervious to rising rates may also exert an undesirable influence on business for a time before the inevitable break. With some qualifications, it may be said that brokers' loans ordinarily merely absor[absorb]funds that the anks[banks]are unable at the moment to employ otherwise. But when security markets begin to absorb increasing funds at 5 per cent and upwards they do attract funds from other uses and tend to force up rates for those other uses.

In the good old days before the World War it used to be said in London that a 7 per cent Bank of England rate would draw gold from the ground. Similarly, it may be said that a 5 to 6 per cent call rate in New York will attract funds from hundreds of banks in every section of the country, tending to subject borrowers everywhere to a higher range of rates. In sum, a crazy stock market is objectionable, both during its final stage of expansion as well as on account of the consequences of its ultimate collapse.

Responsibility for the present situation in the security markets is widely diffused, but the reserve banks can not escape some considerable share in that responsibility. Stability in the money market has been an avowed policy of the reserve system, and the achievement of stability has been emphasized as one of its notable accomplishments. But under some conditions the maintenance of stability may breed a dangerous situation. There are indications that clever speculators are relying upon the predilection for stability of the reserve authorities to protect the market from extreme strain. It is assumed that in no circumstances will liquidation be allowed to become sudden and violent. This is a dangerous assumption, not because it may not be realized but because it removes a restraining influence.

ALTERNATIVES AND CONSEQUENCES

If now we venture upon a look into the future, we are confronted with two contrasting possibilities in reserve bank policy. A passive, or at least relatively quiescent position may be taken. Reliance may be placed upon the gradual tightening of the money market in response to further gold exports and an increased demand for commercial loans. This is a policy which, unless the stock market speedily collapses from its own weight, may be expected to lead to a further advance in discount rates of the reserve banks in all districts, an advance for which local business requirements would be in no sense responsible.

The present situation in the security markets might, however, be subjected to the corrective of sharp and drastic action. But is the patient now in condition to warrant the adoption of a surgical operation? At the beginning of the present movement the risk would certainly have been by no means as incal

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Mr. BEEDY. HOW is it that they have come to this predeliction [predilection]?

Doctor SPRAGUE. Why, in general Mr. BEEDY. Let me ask you this question: Is it true that the board has at times pursued such hesitating policies that the speculative world has concluded that it may well go on with a rising price tendency, knowing full well that the board will hesitate to apply the checks ?

Doctor SPRAGUE. Well, perhaps so.

Mr. BEEDY. IS it not so ? Is it not a fact ? Can you not answer it yes or no.

Doctor SPRAGUE. Many of these questions are difficult to answer yes or not.

I think I can answer that yes, and to illustrate the ingenuity of the speculative community let me take this point. It was quite generally believed about the street that no great amount of pressure would be exerted in March of this year because of the Treasury financing. The desire of the Treasury to market its securities so as to save one-eighth of 1 per cent more or less is recognized on the street as perhaps exerting quite a potent influence at certain periods.

Mr. BEEDY. NOW, Doctor, I am left in this state of mind. Here is a situation at the present time demanding some action, some courageous action by the Federal Reserve Board if an ascent in rates is to be checked so that it will not become highly disadvantageous to business in general. You say, and others think, that the existing law needs no amendments, that the powers are already there, and we also seem to admit quite generally that many times in crises the board has pursued a hesitating course.

Now, I assume that the purpose of the men who are behind this legislation is to meet that very situation and to make it mandatory upon the board, which has been hesitating and feeble in times of crises, to exercise the powers which they already have. Is that an unreasonable demand?

Doctor SPRAGUE. NO, it is not; but the particular situations which you say imply hesitation do not seem to me to be generally the situations that are of the type that are very definitely covered in this bill.

If they are, well and good; I should be delighted.

Mr. STRONG. What would you suggest, Doctor ?

Doctor SPRAGUE. I can not suggest anything. The only thing I can suggest is that with experience the management of the Federal reserve banks will take more definite action than it has at times taken. The system is a cumbersome system, and the number of people who must agree upon a particular course is rather large, the officers of the banks, the directors of the banks, and the board.

Mr. BEEDY. I S that true as to open-market policy ?

Doctor SPRAGUE. The open-market policy has a committee of five.

It is necessarily in large part influenced by views in the New York bank, because it is in the New York market that most of the openmarket operations must occur. But then there must be an agreement between the open-market committee and the Federal Reserve Board, and, further, there must be consideration, I take it, of the predilection of the Treasury for getting the best possible rate on its certificates, so that you have got a diverse group that must reach an agreement before any action can take place, and that inevitably

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Mr. BEEDY. What other tendency, Doctor, would such a law have but to prick them a bit and stimulate their courage ?

Mr. KING. YOU do not need a declaration of Congress to do that.

Doctor SPRAGUE. It might do as you say, but inasmuch as the management of the Federal reserve banks involves the exercise of judgment in many somewhat confusing situations, I think it is the character of the men and the experience that is developed by the passage of time upon which we must mainly rely.

Mr. BEEDY. DO you not think it would be a good thing for these men to be able to say, "Well, we no longer have to wait; we are commanded to act" ?

Doctor SPRAGUE. It is possible.

Mr. BEEDY. Would you not say " probable " ?

Doctor SPRAGUE. Not until I had discussed the matter with quite a number of people who are charged with the responsibility of conducting the system.

Mr. STRONG. I can tell you what they will say. They will say, " Leave us alone."

Mr. WINGO. Aside from the bill, I am inclined to doubt the possibility of any legislative declaration giving either wisdom or courage to anybody.

Mr. BEEDY. It will not give them any courage, but it will serve as an incentive.

Mr. WINGO. Moral support.

Mr. BEEDY. Moral support.

Mr. STRONG. I would like to have the doctor give his opinion on the other clause of the bill, that of publicity, and the direction for an intensive study of this question.

Doctor SPRAGUE. I can do that in a very few moments, I think.

Mr. KING. Can you make a man study by legislation ?

Doctor SPRAGUE. The provision about publicity is very much improved since it contains the word " thereafter," which will give the governor of the board power to defer to a convenient and proper time any statement of reasons for policies that have been pursued by the board and by the banks. I think it will probably serve a useful purpose and "would have served a useful purpose if somewhat more detailed analyses of the purposes of the various policies and the process of executing them and the results of those policies in execution had been set out, although the reserve banks already have done much more than any other central banks, but I think they might do somewhat more than has been done in the past, and this section seems, therefore, to my mind, unobjectionable.

Now, with regard to these studies, they suggest various lines of investigation, some of which probably have been followed and will be followed in the absence of this legislation, and they indicate some other lines of investigation which have not yet been developed.

I take it that this investigation paragraph does not limit the investigations in any way, that the sort of investigations that have been made in the past, and other investigations not indicated here, could properly be undertaken by the reserve banks. The difficulty that I see about some of these investigations is rather in securing an adequate number of competent investigators, but that is a detail of administration. Upon the whole, I see no objection whatever to 15029—28 11

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sensitive to the usual normal extent to advances in rates actually made and more or less threatened in the future.

When you take all those factors together you have, it seems to me, the earmarks of a situation that is getting or may get out of hand.

Now, I do not believe that a contraction in brokers' loans, if it should come in the near future, will involve an extreme decline in quotations of catastrophic proportions. I believe that with the abundance of savings currently made in this country there is a large buying demand for securities at moderate concessions in price.

The CHAIRMAN. Some of this increase in price in the stock market is due to anticipation that we are going on a lower net interest return basis, is it not?

Doctor SPRAGUE. It is; and until recently I had held that that was an adequate explanation for the general upward movement in quotations, but in a period of abundant savings and also in a period in which the accumulation of capital is adequate to meet business requirements, from time to time, a slackening in the upward movement is desirable in order that we may go forward perhaps on a more healthy basis a little later.

Mr. BEEDY. Doctor, I am wondering if I made my question quite clear or if you misunderstood it a bit as to the desirability of prohibiting the use of the credit of the the system for speculative purposes, etc.? You began your answer by what the member banks might do. Of course, I did not refer to member banks, but my question was directed to the thought that that inhibition and direction might be upon the Federal Reserve Board and the central banks.

Doctor SPRAGUE. Assume that a bank has made some of these loans and then is temporarily deficient in its reserve. It wishes to rediscount. I should be inclined to think that unless there is clear evidence of an unsound and undesirable situation developing that satisfactory the operation of the credit machinery of the country renders it advisable that the rediscount should be made almost as a matter of course.

A certain amount of speculation is desirable and necessary in order to create a market, both for commodities and for securities. Assuming an abundant cotton crop, the holding of that is facilitated by the readiness of some people to speculate in cotton and borrow in order to do so. It is only the excess of speculation that may be a serious matter, such as seems now to be present, and the general prohibition would destroy elasticity in the functioning1 of the reserve banks in their relations to the member banks to a most undesirable degree.

The CHAIRMAN. I suggest that it is 1 o'clock.

Mr. KING. I just want to ask him a question.

I was not here when you first went on the stand, and I very much regret it, but I want to know whether you are a fellow in the society of the learned who had their convention here in Washington during the early part of this year ?

Doctor SPRAGUE. I did not attend that meeting, although I am a member of the association in good standing, I hope.

Mr. KING. Thank you.

The CHAIRMAN. The committee will adjourn until to-morrow morning at 10.30.

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